The next component, capital invested, is the amount of money used to fund a particular project. We will also need to calculate the weighted-average cost of capital(WACC) if the information is not provided.

The idea behind multiplying WACC and capital investment is to assess a charge for using the invested capital. This charge is the amount that investors as a group need to make their investment worthwhile.

Let's take a look at an example.

Assume that Company XYZ has the following components to use in the EVA formula:

NOPAT = $3,380,000Capital Investment = $1,300,000WACC = .056 or 5.60%

EVA = $3,380,000 - ($1,300,000 x .056) = $3,307,200

The positive number tells us that Company XYZ more than covered its cost of capital. A negative number indicates that the project did not make enough profit to cover the cost of doing business.

Why It Matters

Economic Value Added (EVA) is important because it is used as an indicator of how profitable company projects are and it therefore serves as a reflection of management performance.

The idea behind EVA is that businesses are only truly profitable when they create wealth for their shareholders, and the measure of this goes beyond calculating net income. Economic value added asserts that businesses should create returns at a rate above their cost of capital

The economic value calculation has many advantages. It succinctly summarizes how much and from where a company created wealth. It includes the balance sheet in the calculation and encourages managers to think about assets as well as expenses in their decisions.

However, the seemingly infinite cash adjustments associated with calculating economic value can be time-consuming. And accrual distortions can still affect the measure, particularly when it comes to depreciation and amortization differences. Also, economic value added only applies to the period measured; it is not predictive of future performance, especially for companies in the midst of reorganization and/or about to make large capitalinvestments.

The EVA calculation depends heavily on invested capital, and it is therefore most applicable to asset-intensive companies that are generally stable. Thus, EVA is more useful for auto manufacturers, for example, than software companies or service companies with a lot of intangible assets.